07 November 2010

BR: Income Statement Analysis for the September 2010 Quarter

Broadridge Financial (NYSE: BR) earned $0.10 per diluted share on a GAAP basis in the September-ending first quarter of fiscal 2011, down 45 percent from $0.19 in the same three months of last year. 

The earlier results benefited from non-recurring activities, which make the latest quarter appear especially weak.

This post examines Broadridge's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Reported earnings were $0.08 per share lower than the $0.18 we had forecast.

The principal sources for this income statement analysis were the earnings announcement, the conference call presentation, the call transcript (available from Seeking Alpha), and the formal 10-Q report.

In a second article, we will report Broadridge's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

Broadridge Financial Solutions, Inc., (NYSE: BR) provides brokerage and other services to financial companies.

Broadridge earned $190 million ($225 million from continuing operations) in fiscal 2010, which ended in June, on revenue of $2.2 billion.  The company earned $223 million and had revenue of $2.1 billion in 2009.

Automatic Data Processing (NASDAQ: ADP) spun off Broadridge on 30 March 2007.  (GCFR articles related to ADP can be found here.)  Broadridge sold its securities clearing business to Penson Worldwide (NASDAQ: PNSN) on 25 June 2010.

The market value of Broadridge is currently about $2.8 billion.

Broadridge, for financial data reporting, divides its operations into two business segments:  Investor Communication Solutions (ICS) and Securities Processing Solutions (SPS).  The ICS segment, which contributed more than 75 percent of Broadridge's revenue and pretax earnings in fiscal 2010, distributes and processes proxies for public companies and mutual funds.

The SPS business, as described by the company, provides real-time transaction processing services, including order capture and execution, trade confirmation, settlement and accounting to financial institutions to support global trading of equity, option, mutual fund, and fixed income securities.  Broadridge in fiscal 2010 "processed on average over 1.5 million equity trades per day and over $3.5 trillion in fixed income trades per day of U.S. and Canadian securities." [emphasis added]

Broadridge's board in August hiked its annual dividend 7 percent to $0.60 per share.  The board also authorized the repurchase of 10 million shares of the company's common stock.  Broadridge had 138 million shares outstanding, on a fully diluted basis, in June 2010.

Additional background information about Broadridge and the business environment in which it is currently operating can be found in the look-ahead.

Please click here to see a normalized depiction of the actual and projected results for the just-concluded quarter, as well as the quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Revenue in the September quarter decreased 3.8 percent, from $438 million last year to $421 million in the most recent three months. 

The Revenue decline was mostly the result of lower fees related to mutual fund proxy distribution, partially offset by small revenue increases due to acquisitions, the new business, and currency exchange rate changes.

Reported revenue was 9 percent, a substantial amount, less than our $461 million estimate.  Our figure was based on Broadridge's earlier guidance to expect fiscal 2011 Revenue growth between 1 percent and 4 percent.  Broadridge had stated that its results in the first half of the fiscal year would be lower than in the second half, but we failed to anticipate how much lower sales would be in the first quarter.

The Investor Communication Solutions business had its revenue fall by 9.8 percent, from $310 million to $280 million. This business, which is the one that distributes proxies and other pieces of documentation, was responsible for 66 percent of the company's total revenue in the quarter.

Revenue from the smaller Securities Processing Solutions business rose 8.9 percent, from $130 million to $142 million.  This rise was due to sales gained from the Penson transaction and from the acquisition of City Networks, Ltd.

The Cost of Revenues -- we call it Cost of Goods Sold  -- increased to $337 million (79.9 percent of Revenue) from $339 million in the September 2009 quarter.  The latest amount translates into a Gross Margin of 20.1 percent, a huge 270 basis points less profitable than last year. 

The Gross Margin was a disappointing 190 basis points worse than the 22 percent we had estimated.

The margin was negatively effected by the drop in event-driven revenues and by added costs related to new business with Penson and Morgan Stanley Smith Barney.

Sales, General, and Administrative expenses increased 15 percent, from $53.4 million to $61.5 million.  As a percentage of Revenue, SG&A rose from 12.2 percent to 14.6 percent.  The company attributed most of the SG&A increase to acquisition costs and "strategic initiatives and investments." (Broadridge acquired NewRiver during the September quarter.)

The latest SG&A expense was 2 percent more than our $55.4 million estimate and $5 million provision for non-recurring expenses included in the reported SG&A amount.

Subtracting the various operating expenses mentioned above from Revenue yields Operating Income, as we define it, of $23.2 million, down 50 percent from $46.3 million in the year-earlier quarter.  The decrease was due to lower Revenue, the less profitable Gross Margin, and the rise in SG&A expenses.

The latest Operating Income value was far below our $41.1 million target.  The difference was mainly due to weaker-than-expected Revenue and the lower Gross Margin.

Other items we classify as non-operating (generally interest income and expense, plus foreign exchange gains and losses) summed to a $2.4 million net expense.  Our target was $3.0 million.

Broadridge's interest payments on long-term debt declined because the average interest rate came down.

The effective Income Tax Rate was 36.4 percent, down from 37.4 percent last year and less than the 38-percent tax rate we expected.  Broadridge notes that the geographic distribution of its income tilted towards countries that levy lower tax rates.

After-tax GAAP Net Income from continuing operations were $13.3 million ($0.10 per share), down sharply from last year's $26.6 million ($0.19 per share).   Fewer diluted shares outstanding added almost $0.01 to earnings in the latest period.

Our Net Income estimate was $23.6 million ($0.18 per share).

In summary, Revenue decreased less than 4 percent in the September quarter.  The drop was not immense, but we had expected a modest rise and were disappointed.  The earlier period included non-recurring "event-driven" sales events, making the latest period appear especially unfavorable by comparison.  Although the Cost of Sales was lower than in the same period a year ago, costs did not drop as much on a percentage basis as sales.  The lower margin, plus acquisition-related and other expenses, caused earnings to fall well below last year's level and our expectations.  Broadridge, optimistic about the second half of the fiscal year, reaffirmed its previous guidance for full-year earnings per share.  Share repurchases -- the company repurchased 4.5 million shares during the quarter -- will help boost EPS growth.

Full disclosure: Long BR at time of writing.

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